CIO Blog: Save our (Dover) Sole

The World’s Who’s Who are in attendance at this year’s annual World Economic Forum in the Swiss Alpine town of Davos.

At the Hotel Belvedere, an epicentre for billionaires, superstar chief executives and heads of state – Donald Trump, who will attend, can arguably claim to be all three – 1,500 bottles of champagne and 1,350 chocolate-covered strawberries will be consumed in five days at 320 different parties in its 126 rooms.

And why not? The luminaries attending the World Economic Forum have much to be pleased about. The global economy is in the throes of a powerful, accelerating recovery. Corporates across the globe have revved up capital expenditures to meet burgeoning business and consumer demand. Even inflation – the missing piece of the recovery for so long – appears to be on an uptrend. Reflecting this rude macroeconomic health – and driven by powerful momentum – global equity markets are at all-time highs.

Then why, pray tell, is the conference littered with the following sessions:

Global Markets in a Fractured World;

The Next Financial Crisis?;

Why Is Our World Fractured?;

How Is Rentier Capitalism Aggravating Inequality?;

Could 2018 Be the Year of the Next Financial Crisis?;

How Can We Fix Our Productivity Crisis?;

The Remaking of Global Finance;

and, perhaps the most morose, Saving Economic Globalization from Itself.

Why the angst?

Part of the answer lies in the still powerful hangover of the populist upheavals of 2016. The stunning presidential victory of Donald Trump in the United States and the Brexit vote in the UK was jarring wake-up call of a new social paradigm which does not look kindly upon the Davos-set.

While 2017 saw victories for centrists in France and the Netherlands, excellent result for the right-wing Alternative for Germany party in recent elections reminded us that plenty of anger and displacement – resulting from the unequal spread of wealth – exists. As recently as between 1993 and 2005, 98% of households in 25 advanced economies saw real incomes rise1. However – in the decade that followed – real incomes fell, or were flat, for two-thirds of households in those countries. This equates to 540 million people. It bears repeating. 540 million.

The angst has carried on into 2018, Germany still has no government following elections in September. Italy’s populist Five-Star Movement is leading in polls prior to next month’s elections. US President Donald Trump has retained near fanatical support of his unconventional presidency from his “base”, even as he remains under active investigation by a special prosecutor for possible collusion with Russia to get his current job. Brexit negotiations remain fraught, and there is a genuine possibility of a Jeremy Corbyn-led Labour government, a few years ago, this would have a probability at par with an alien invasion.

There is no perfect answer to the deeply structural problem of inequality. In the short-term, it would be most prudent for those in positions of power to revisit tax and redistributive policies. Judging by the session titles, they are.

Investment Implications

But what does this all mean for investors? Liquid financial assets – equities, bonds and cash – are all increasingly expensive, with few, if any, bargains on the investment horizon. Nonetheless, it appears that the hard prudence learned from the previous financial crisis is waning. Latest asset surveys2 show fund managers’ proportion of equities in portfolios is at its highest level since 2014; and hedging against a near-term sell-off is at its lowest since 2013. Small, retail investors are also getting increasingly piqued: 60% said they believe stocks will be higher over the next six months, the highest percentage since 20103.

While one should remain vigilant against overbought sentiment, anyone invested over the last few years cannot be faulted for having a bit of champagne, and perhaps even a chocolate strawberry or two.

At present, the global economy is in an expansionary phase, and this growth is translating into earnings, supporting the equity bull markets, and keeping expensive valuations from overheating. Indeed, the ongoing fourth-quarter earnings season in the US may well be the first time in six years that both sales and earnings rise for all 11 sectors in unison. Furthermore, powerful momentum remains with markets: flows into equity funds reached a six-month high in January. Emerging market inflows hit their highest level in 18 months; the technology sector hit a three year peak.

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